Читать книгу Active Investing in the Age of Disruption - Evan L. Jones - Страница 31

The second major factor in driving innovation is risk capital. Entrepreneurs and researchers can move only as quickly as access to capital allows them to take losses. By definition, early innovation is not profit producing and needs development and growth capital. Access to risk capital driven by investors' appetite for risk is the number one factor in the pace of innovation. Whether that innovation be a start-up in Silicon Valley or new projects at Amazon and Google, the appetite for risk capital by investors is a determining factor.

This is where the confluence of central bank intervention and the accelerated pace of technology compound to dramatically increase disruption. Almost every industry is being disrupted in some fashion, and companies no longer stay within their industry verticals. Google is disrupting industries from autos to medical devices. Amazon is no longer just threatening retail but has moved into everything from health care to cloud computing. The competitive environment can no longer be narrowly defined by industry. This would not be possible if investors were demanding earnings. It would not be possible if money were not moving aggressively into private equity, and it would not be possible if interest rates were 400 basis points higher than they are today.

Venture capital is the clearest indicator of investor willingness to finance innovation and accept losses in a quest for growth. More US venture capital has been invested in the last five years than the previous ten years combined. Figure 3.4 illustrates venture capital investing since 2004 and the huge growth in the last five years. Pre–2008 financial crisis investing levels that were considered high at the time have been surpassed every year post–financial crisis.

FIGURE 3.4 US venture capital invested by deal flow (billions of $US)

FIGURE 3.5 US share of global venture capital

This is not solely a US phenomenon. Venture capital outside the US has been growing even faster. As evidenced in Figure 3.5, the US now accounts for about 52% of global venture capital assets, whereas China and the rest of the world (RoW) split the remaining share. The US dominated venture capital for decades and even as recently as 2012 held 70% of the global share. A focus on education in science, technology, and engineering throughout the emerging world, especially China and India, has spurred innovation. Venture capital has followed the human capital to India and China. India and China both now have the human capital and growth potential to support a thriving venture capital community. For decades, the US has innovated and designed, and the rest of the world has copied and produced. The 2020s will start to see that US innovation advantage be diluted.

The other significant change is that venture capitalists are no longer seeding just start-ups and emerging companies and racing to bring them public or sell them. They are holding companies privately longer than ever before allowing them to operate in a non-earnings-driven environment. This change enhances the ability to both innovate and disrupt, because earnings are not a focal point until much later in the life cycle of the company. The life cycle of a successful venture capital company has changed. Figure 3.6 shows the average age of a successful company to go public in 2000 was six years, and the average acquisition time frame four years. This life cycle has almost doubled, because venture capital firms maintain private ownership longer.

The term unicorn was coined to designate a venture-backed company with an equity valuation greater than $1 billion. Prior to the 2008 financial crisis, unicorns were practically nonexistent. Any company with a valuation approaching $1 billion would have entered the public markets to access capital and create liquidity. Now, venture capital funds are so large they can sustain companies longer privately and absorb more losses. Managing a company for profit is something that can be pushed into the future. Figure 3.7 illustrates US venture capital invested in unicorns on an annual basis. In 2018, $46.4 billion was invested in companies with an equity valuation greater than $1 billion. Ten years ago that number was less than $5 billion.

FIGURE 3.6 Average time being held privately of venture capital backed companies

FIGURE 3.7 US venture capital invested in unicorns (billions $US)

Reviewing the initial public offering activity, in Figure 3.8, it is clear that companies are staying private longer. There is no longer the need to access capital publicly for the allure of being a public company. As Figure 3.8 illustrates, the 2010s saw the lowest number of new IPOs in many decades. In addition to having very few IPOs, the profitability of those IPOs was very low. The solid line in the chart below tracks the percentage of companies that are profitable on their IPO date. In 2019, 81% of the companies that came public were unprofitable. That level of negative earnings for companies has not been seen since the dot-com era. These are all indications that the capital markets are allowing companies to focus on taking market share over profits.

FIGURE 3.8 Initial public offerings (IPOs)

A portion of the risk capital coming into new ventures is coming from public companies hoping to find the next industry disruptor themselves before, or at least alongside, venture capitalists. Through corporate subsidiaries, public companies have created their own venture arms to try and foster innovation both synergistically and totally independently of their core enterprise. Prior to the 2008 financial crisis, these corporate venture capital funds held between $5 billion and $10 billion. Today the number has reached $66 billion, as much as a ten times increase. Corporate venture funds were involved in 51% of all venture capital deals in 2018, a significant increase from 25% ten years ago. Figure 3.9 demonstrates the significant increase in corporate interest in venture capital.

FIGURE 3.9 US corporate venture capital raised (billions $US)

Venture success leads to financially successful entrepreneurs and investors, which leads to a greater supply of young, eager innovators willing to take chances and spend their time on new ideas. Human capital focuses on innovation increases, when financial capital is successful.

In June 2019, 26% of the companies in the broad Russell 3000 US Index had zero earnings. With the exception of the 2008 financial crisis period (when investors did want profits, but they were scarce), that is the highest percentage of unprofitable companies in the index ever. Additionally many companies are profitable, but they are trading at very high valuation multiples as they invest in growth internally. Amazon, the most prominent disruptor, threatens every industry vertically and has the capital and backing of Wall Street to take large losses during the disruption period.

All this capital focused on innovation has materially accelerated the pace of technology and with it disruption. This significant innovation cycle probably does not sound like a bad outcome for society, and from many perspectives it is quite positive. I hope society reaps long-term benefits despite some shorter-term challenges of necessary new regulations and the growing pains of change. Unfortunately, viewed through the lens of a fundamental public equity markets investors, it brings many challenges. Any time the financial markets move away from the analysis of cash flow and paradigm shifts become common, fundamental investors will struggle.